Market Structures, Productive and Allocative Efficiency
Introduction
Firms operate under several market structures, as distinguished by neo-classical theory (Arnold 2001). Each of these market structures is unique in terms of its own assumptions and characteristics. The type of structure defines a firm’s behaviour in terms of profits generated and efficiency. The four main market structures are: perfect or pure competition, monopolistic competition, monopoly, and oligopoly. The premise of this essay is to outline and compare the characteristics of these four market structures, in addition to exploring their allocative and productive efficiencies.
Monopolies
Since the firm does not have competitors, it exerts total control over the supply of such a product. The firm could also erect barriers to entry into the market, thereby putting off potential competitors (Simpson 2005). Most monopolies in existence today are local utility firms. These enjoy heavy regulation by federal, local, and state agencies (Simpson 2010).. On account of the unique nature of the product of a monopoly, and given the lack of close substitutes, the firm becomes a price maker and hence exerts a lot of control over price. Since a monopoly produces a product with no close substitutes, the firm affects the price of such a product through a change of supply. Should the monopolist desire to sell more of a product, all they have to do is lower the product price. Conversely, the monopolist can decide to increase the price and sell less. Since there is no distinction between industry and firm under a monopoly, the demand curve of both the firm and industry is also similar. The monopolist is characterised by an Average Revenue (AR) demand curve, which tends to slope downwards, as shown by figure 1 below:
(Source: Simpson 2010)
From figure 1 above, it is evident that a lower price translates into more quantity of products sold. Under monopoly, we experience a downward slope of the demand curve. The implication made is that in the event that the monopolist sets high prices, there is a resultant fall in demand. Moreover, in monopoly, both the MR (Marginal Revenue) and AR curves are quite distinct but slope downwards.
Oligopoly
In an oligopoly, in an oligopolistic market, a few sellers are responsible for the control of a large “a large proportion of a product” (Pride & Ferrell 2014, p. 57). In an oligopoly, an individual seller considers how other sellers are likely to react to alterations in marketing activities (Ferrell et al. 2014). An oligopoly is characterised by either differentiated products (for example, cars), or homogeneous products (for example, aluminium). Unlike the monopolistic competition, perfect competition, and monopoly, oligopoly calls for strategic thinking. Under monopolistic competition, perfect competition, and monopoly, the firm encounters a well-defined demand curve for its products (Mukherjee 2002). The firm is not concerned about how other firms are likely to react, since either the firm is already a monopoly, or negligibly small. Under an oligopoly market structure, however, a firm is large enough to affect the market. Accordingly, firms have to respond to choices made by the competition, but the competition is also responding to the choices made by your firm (Mazzeo 2002). Oligopoly markets are characterised by tension between self-interest and cooperation. In the event that firms decide to limit their output, this would obviously drive up the price of their product. However, firms in oligopoly markets have an incentive to increase their output.
Monopolistic competition
In a monopolistic market structure, there are many potential competitors to a firm. Consequently, the firm is compelled to develop a market strategy that will enable it to differentiate its products from those of the competition. In monopolistic competition, products are not standardised, but are differentiated. Monopolistic competition is characterised by a certain level of control over price, albeit narrowly. On the other hand, there is no price control in purely competitive firms (Ferrel et al. 2014). While pure competition does not have nonprice competition, monopolistic competition experiences much nonprice competition in the form of trademarks, advertising, and brand names. In the market under monopolistic competition is divided based on product differentiation. Although there are many sellers, they sell different products. Each seller's product can be differentiated form that of the competition based on brand, trademark, or quality. As such, both the perfect market and monopoly features exist in monopolistic competition (Arnold 2001). While each seller endeavours to take a price for his product that is different from that of other sellers, they also strive to obtain the best price in the market. Consequently, the price in such a market is not fixed at the point of intersection of quantity supplied and quantity demanded. Rather, price under monopolistic competition is determined at the point where marginal cost equals marginal revenue.
Pure competition
In a pure competition market structure, there are very many sellers in the market, but none of these sellers commands considerable strength that would enable it to influence the price of the product. A perfect competition market is characterised by a relatively large number of sellers and buyers (Singh & Zhu 2006). Products in a perfect competition market are homogeneous in that various units of a product tend to be similar in terms of quality, content, packaging, and price. Firms can also enter and exit the market freely, as there are no exit or entry barriers. All the firms in the perfect competition market desire to maximise their profit. The government plays no role in the perfect competition market. Consequently, there is no tax, licensing system, or subsidy. Sellers and buyers in a perfect competition market are assumed to be knowledgeable about prevailing market prices.
In the perfect competition market, price determination depends on the industry and market forces (Norman & Thisse 2000). In other words, market supply and market demand for the product determine the product's market price. For the firm to cover its fixed costs in the short term, its short-run price ought to equate to its minimum AVC (average variable cost) as shown in figure 2 below:
